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Growth and Poverty Reduction Under Globalization: The Systematic Impact of Exchange Rate Misalignment

The paper presents an assessment of the role of economic growth under globalization in achieving the first target of the Millennium Development Goals (MDGs), namely to halve the incidence of abject poverty in the world by year 2015. The analysis is composed of two parts. First, by following the consensus in the relevant literature we address economic growth as the most effective instrument for achieving poverty reduction. In evaluating the feasibility of this approach we extend the "exit-time" concept and we find that at least one half of all the targeted countries, and the totality of countries in the poorest group, will not achieve the first target of the MDGs if they continue on their historical trajectory of economic growth in the future. This finding highlights the importance of increasing the rate of economic growth, especially for the poorest countries, as a necessary condition of effective poverty reduction. Next we focus on the imperative of accelerating the rate of growth in the poorest countries of the world if the MDGs were to be achieved. In a standard reduced-form growth-regression model fitted with cross country data we introduce the exchange rate misalignment defined as the chronic deviation between the nominal exchange rate and the purchasing power parity rate. We confirm the negative relationship between misalignment and growth and, most importantly, the analysis points to the misalignment of exchange rates as originating in the currency substitution that takes place in developing countries and results in the systematic devaluation of their currencies which, in turn, further exacerbates exchange rate misalignment. This finding highlights the importance of the proper combination of trade and exchange rate policies in fostering growth in developing countries in the current environment of globalization.

Author(s)
Yasuyuki Sawada
Pan Yotopoulos
Publication Date
December, 2006